In Summary
- While profit margins indicate financial vitality, ARM—the system for creating, tracking, and collecting payments—is essential for converting revenue into actual cash flow, which is necessary for paying vendors and loans, driving investments, and sustaining business growth.
- Businesses should establish a process that starts with calculating the accounts receivable turnover (ART) ratio to measure collection speed, while simultaneously making payments easy (e.g., electronic options, lockboxes) and using incentives (discounts) and penalties to encourage prompt payment, all supported by consistent follow-up and automation.
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Maintaining healthy profit margins is undoubtedly essential for the financial vitality of a business. It ensures the company grows and provides the financial foundation to drive market expansion, new investments, or technology upgrades. However, profit margin alone is not sufficient to sustain a business. After all, it is one thing to generate revenue, and it is another to collect it. Outstanding invoices and overdue payments can negatively impact cash flow, hindering the growth and stability of a business. For this reason, it is essential to focus on accounts receivable management to ensure timely collections. To help clients, prospects, and others, Hanson & Co has summarized the key details below.
What is Accounts Receivable Management?
Accounts receivable management (ARM) is a system businesses can implement to ensure they receive the money billed to clients and customers. It involves creating and tracking invoices, collecting payments, and minimizing risk by identifying customers who are slower to pay. ARM aims to return money to the business faster, ensuring a steady cash flow and improving financial health.
What Can Happen Without a Steady Cash Flow?
Businesses that fail to implement accounts receivable management may have cash flow problems. The potential unreliability of others can negatively impact the industry and every payment they have to make. For example, poor cash flow can prevent businesses from paying loans, vendors, and even employees on time.
Cash flow should not prevent businesses from advancing or growing. It’s necessary to have a strong cash flow to buy new assets, modernize tools, and manage regular expenses. Managing accounts receivable isn’t something that should be left up to chance. Instead, businesses should put a process in place for how to collect and how to proactively solve cash flow issues.
Here are some tips businesses can use to start implementing an accounts receivable management system or brush up on current practices.
Create a Process and Understand ART
A strong management process starts with understanding business baselines. By making an accounts receivable aging report, companies can understand how quickly clients usually pay, identify entities that are often delinquent, and calculate the amount owed to them at any given time.
Another way to calculate healthy cash flow is to use the Accounts Receivable Turnover (ART) ratio. This value tells businesses how many days, on average, it takes to collect an invoice payment.
The ratio is calculated by taking the Net Credit Sales and dividing it by Average Accounts Receivable. Net Credit Sales are the total revenue earned by the company from credit sales, excluding cash sales and reductions for returns or allowances. The average accounts receivable is the average amount of money customers owe on credit sales throughout a period. Generally, this is calculated by adding the beginning and ending balances and then dividin them in half.
Say a company has net credit sales of $500,000 during the course of a year and an average accounts receivable amount of $50,000. The turnover ratio would be 10, meaning that 10 times during the year, the business collects payment or every 36.5 days.
Make Paying Invoices Easy
One of the biggest barriers businesses may encounter lies within their own payment systems. If it’s difficult or confusing to pay an invoice, customers are less likely to do it quickly. Here are a few things organizations can do to make their invoices easy to pay:
- Include detailed and descriptive information so the customer knows what they are being billed for
- Add electronic payment ACH (automated clearing house) options
- Allow customers to save payment information or accept automatic payments
- Provide a lockbox location where clients can mail checks. The bank can monitor, collect, and deposit checks sent to this lockbox.
Create Benefits and Penalties for Early and Late Payments
Some clients and customers will turn around payments quickly, but others may need some coaxing and incentives. Businesses could choose to reward early payments, penalize late payments, or both to improve cash flow.
Rewarded behavior could look like a percentage discount for early payments or money off for paying upfront for larger package deals. This should only be done if the business has wiggle room to allow for the discount, so it’s not right for every organization. A more neutral policy could be requiring deposits from clients to ensure some of the payments come through early. This could also be set at any percentage that makes sense for the industry and margins of the business. To discourage clients from making late payments, businesses can also implement penalties. If a penalty isn’t in place, give current clients a grace period to adjust to the new rule before fully implementing it.
Diversify Methods for How Businesses Can Pay
ACH payments are one way companies can make it easier to get paid on time, but businesses may also choose to offer other options, such as debit and credit card payments.
Organizations may also choose to allow payment plans for certain customers or invoices above set amounts. This could be done for an outstanding payment or be set up at the beginning of an engagement, extending additional flexibility to clients. However, payment plans must also have clear terms, just like initial billing agreements.
Remain Consistent and Persistent
Consistency is key when it comes to setting expectations and following up to close invoices. The sooner an accounts receivable team can contact a client about a missed payment, the better. Create a routine system that involves calling as soon as the payment is late, with follow-ups scheduled at regular intervals. Persist and escalate where necessary, using the help of a collection agency if the delinquency is too high.
Automate Where Possible
Finally, automation can reduce manual work and speed up the process of receiving money. Teams can automatically send out invoice reminders and recurrent billing to customers, freeing them up to work on more stubborn issues. By being consistent and setting expectations early, these automated reminders should come as no surprise to recipients. New clients should understand how billing is conducted during the onboarding process. For established clients, communicate that the billing process is changing and the business has new policies.
Contact Us
Accounts receivable management is an essential practice that Denver businesses need to embrace to maintain a positive cash flow. It’s far better to proactively implement policies than wait until an issue arises. If you have questions about the information outlined above or need assistance with another accounting or Virtual CFO issue, Hanson & CO can help. For additional information, call 303-388-1010 or complete the form below. We look forward to speaking with you soon.